– Analysis of Stock Prices and Exchange Rate Interactions in Nigeria –
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ABSTARCT
The need to capture stock market and foreign exchange market nexus in Nigeria is underscored by the rapidly expanding financial markets integration due to trade and financial liberalization policies which seem to have enhanced the inflow of capital as well as accelerated investment/business interactions.
Theoretically, the relationship between stock prices and exchange rate can be either positive or negative and can also run either way.
This study therefore captures returns/mean and volatility spillovers between the stock and foreign exchange markets in Nigeria.
The study empirically analyzes stock prices and exchange rate interactions with VAR and multivariate generalized autoregressive conditional heteroscedasticity (GARCH) models using monthly data from January 2000 to October 2014.
The results of the E-G and Johansen cointegration test show that there is stable long-term equilibrium relationship between stock prices and exchange rate.
The empirical evidence of the VAR-GARCH model shows a significant mean spillover running from stock market to exchange market but not a mean spillover from exchange market to stock market.
TABLE OF CONTENTS
Chapter One: Introduction
1.1 Background of the Study ………………………………………………………… 1
1.2 Statement of the Problem ………………………………………………………… 4
1.3 Research Questions ……………………………………………………………… 6
1.4 Objectives of the Study ………………………………………………………… 6
1.5 Research Hypotheses ………………………………………………………… 7
1.6 Significance of the Study ………………………………………………………… 7
1.7 Scope of the Study ……………..………………………………………….. 8
Chapter Two: Overview of the Foreign exchange and Stock Market Development in Nigeria
2.1 Foreign Exchange Market in Nigeria. ..…………………………………………….. 9
2.1.1 The Exchange Rate: Pre SAP period (1970-1986). ..……………………………. 9
2.1.2 The Exchange Rate: Under SAP period (1986-1995). …………………………… 10
2.1.3 The Exchange Rate: Post SAP period (from 1995). …………………………….. 11
2.2 Stock Market Development in Nigeria. ……………………………………………. 12
2.2.1 Market Infrastructure. ………………………………………………………… 13
2.2.2 Internationalization of the Nigerian Stock Market. ……………………………….. 13
2.2.3 Investors Marker awareness. ……………………………………………………14
Chapter Three: Literature Review
3.1 Conceptual Literature. ……………………………………………………..… 15
3.1.1 Stock Market/Price. …………………………………………………..…… 15
3.1.2 Exchange Rate. ………………………………………………………… 16
3.2 Theoretical Literature ……………………………………………..………… 17
3.2.1 Flow Oriented Model. ……………………………………………………….. 18
3.2.2 Stock Oriented Model. ……………………………………………………… 19
3.2.2.1 Monetary Model.………………………………………………………. 19
3.2.2.2 Portfolio balance Model.………………………………………………… 20
3.3 Empirical Literatures. …………………………..…………………………… 23
3.3.1 International Studies. ……………………………………………………….. 23
3.3.2 Domestic Studies. …………………………………………………………… 41
3.4 Gap in Previous Studies in Nigeria and Value added ………………. 44
Chapter Four: Research Methodology
4.1 Theoretical Framework. …………..…………………………………………… 46
4.2 Model Specification ……………………………………………………………. 47
4.3 Justification of the Model ……………………………………………………… 49
4.4 Estimation Procedure. …………………………………………………………. 50
4.4.1 Unit Roots Test.s …………………………………………………………… 50
4.4.2 Cointegration Test. ………….…………….…… ………………… ….…… 51
4.4.2.1 Engle and Granger (1987) two-step methodology …………………………… 51
4.4.2.2 Johansen Cointegration test ………………………………………………. 52
4.4.3 ARCH Effects Test ………………………………………………………… 53
4.5 Data Sources and Software for Analysis. ……………………………………………………….. 53
Chapter Five: Presentation and Analysis of Results
5.1 Descriptive Statistics …………………………………………………………… 54
5.2 Unit Roots Test Result …………………………………………………………… 54
5.3. Co-integration Test Result …………………………………………………….. 55
5.3.1. Engle and Granger (1987) two-step Cointegration Tests Results …………………… 55
5.3.2 Johansen Cointegration Test Result ……………………………………………… 56
5.4 ARCH Effects Result ………………………………………………………… 57
5.5 VEC-GARCH Model Result …………………………………………………….. 57
Chapter Six: Summary of Findings and Policy Recommendations
6.1 Summary of Findings ………………………………………………………… 61
6.2 Policy Recommendations ………………………………………………………… 62
References
Appendix
BACKGROUND OF THE STUDY
The relationship between stock prices and exchange rate has attracted much attention amongst financial expert, researchers and policy makers in Nigeria since the inception of the Structural Adjustment Programme (SAP) in 1986.
The period witnessed significant changes in the Nigerian financial system, such as the emergence of new equity markets in terms of liberalization policy.
This era saw the abolishment of trade barriers on capital flows and adoption of flexible exchange rate, which subsequently result to verities of investment opportunities.
Hence, the broadened investment opportunities in turn promote frequent inflow and outflow of investment into the market.
As a result, this has led to the increase in demand and supply for local currency and thus, the volatility in exchange rates that sometime affect the investment decisions and portfolio diversification of many investors.
However, the understanding of the influence of exchange rates on stock prices and their interactions in Nigeria cannot be over-emphasis.
This is because of the significant role they play in stabilizing the macroeconomic environment, which in turn spur economic growth and development.
Though, there has been thoughtful disagreement on the relationship between stock prices and exchange rate. It has been argued that the interplay of demand and supply of domestic currency partly determined stock price movement (Bahmani-Oskooee & Sohrabian, 1992).
REFERENCES
Abdalla, I.S.A., & Murinde, V. (1997). Exchange Rate and Stock Price Interactions in emerging Financial Markets: Evidence of India, Korea, Pakistan and Philippines. Applied Financial Economics, 7, 25-35.
Adam, A.M & Tweneboah, G. (2008). Macroeconomic Indicators and Stock Market movement:Evidence from Ghana. MPRA Paper, No. 14079.
Adebiyi, M.A., Adenuga, A.O., Abeng, M.O. & Omanukwue, P.N. (2009). Oil Price Shocks, Exchange Rate and Stock Market Behaviour: Empirical Evidence from Nigeria. A paper presented at the 15th Annual African Econometric Society (AES) Conference on Econometric Modeling for Africa Held in Abuja from July 07 – 09.
Adjasi, C. K.D., & Biekpe, B.N. (2007). Stock Market Returns and Exchange Rate Dynamics in
Selected African Countries: A bivariate analysis. Retrieved March 27, 2014
Adjasi, C.K.D, Harvey, S.K & Agyapong, D. (2008). Effect of Exchange rate volatility on the
Ghana stock exchange. African Journal of Accounting, Economics and Banking research,
3(3), 28-47.Adler, M. & Dumas, B. (1984). Exposure to Currency Risk: Definition and Measurement. Financial Management / Summer, 41-50.
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